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NON-FUND BASED LIMITS

LETTERS OF CREDIT &

BANK GUARANTEES

R VENKATESHCHIEF MANAGER & FACULTY

STATE BANK ACADEMY

GURGAON


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OVERVIEW

1. LETTERS OF CREDIT

2. BANK GUARANTEES


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CHAPTER 1LETTERS OF CREDIT


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INTRODUCTION

Facilitates trade : Domestic and International

Helps in reducing FBWC requirement for buyer

Helps seller to get immediate payment though creditis extended by him

Bank intermediate lends its creditworthiness forwhich it charges the applicant

Transactions are guided by UCPDC


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INTRODUCTIONA Letter of Credit (LC) is an arrangement whereby a

bank (the issuing bank) acting at the request and onthe instructions of a customer (the applicant) or onits own behalf,

i. Is to make a payment to or to the order of a third

party (the beneficiary), or is to accept and pay bills ofexchange (drafts drawn by the beneficiary); or

ii. Authorises another bank to effect such payment, or to

accept and pay such bills of exchange (drafts); oriii. Authorises another bank to negotiate against

stipulated document(s), provided that the terms andconditions of the credit are complied with.


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INTRODUCTION

In other words, a Documentary Credit is an

undertaking issued by a bank (the issuing bank), onbehalf of the buyer (the applicant), to the seller (thebeneficiary) to pay for goods and services providedthat the seller presents documents which comply

with the terms and conditions of the DocumentaryCredit.

Except as otherwise stated, Documentary Credits

(LCs) are subject to the terms and conditions ofUCPDC, ICC Publication No. 500 (1993).


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PARTIES TO A LETTER OF CREDIT

Applicant (Buyer / Importer)

Issuing Bank (LC Opening Bank)

Advising Bank

Confirming BankBeneficiary (Seller / Exporter)

Negotiating Bank (Paying Bank)

Reimbursing Bank

Second Beneficiary


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DOCUMENTARY CREDIT PROCEDURE

1. The Buyer and Seller conclude a sales contract

providing for payment by a Documentary Credit(DC).

2. The Buyer instructs his bank (the Issuing Bank)

to issue a DC in favour of the Seller(Beneficiary).

3. The Issuing Bank issues the DC and asks

another bank (the Advising Bank), usually in thecountry of the Seller to advise or confirm the DC.

4. The Advising Bank informs the Seller that the DC

has been issued.


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5. As soon as the Seller receives the DC and is

satisfied that it meets the terms of the salescontract and that he can meet the DC terms andconditions, he is in a position to effect shipment.

6. Seller then sends the required documents to thebank where the DC is made available (theNominated Bank).

7. The bank examines the documents against theDC. If they meet the requirements of the Dc,the bank will pay, accept or negotiate, accordingto the terms of the DC.


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8. The bank which takes up the documents sends

the documents to the Issuing Bank.

9. The Issuing Bank examines the documents and ifthe documents meet the DC requirements,

reimburses in the pre-agreed manner theConfirming Bank or any other Nominated Bankthat has paid, accepted, or negotiated under theDC.

10. When the documents have been examined bythe Issuing Bank and are found to meet the DCrequirements, they are released to the Buyer.


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11. The Issuing Bank obtains reimbursement from

the Buyer in the pre-agreed manner.

12. The Buyer forwards the transport document tothe local office or agent of the carrier who will

then effect delivery of the goods to him.


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TYPES OF LETTERS OF CREDIT

1. With / without backing of documents:

Clean LC

Documentary LC

2. Security wise:

Revocable LC

Irrevocable LC

Confirmed LC

3. Payment wise:

Sight LC

Acce tance LC


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TYPES OF LETTERS OF CREDIT

4. With advance payment:

Red Clause LC

Green Clause LC

5. Involving middlemen:

Transferable LC

Back-to-back LC

6. Others:

Revolving LC

Standby LC


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OPENING OF LCs : PRECAUTIONS

1. Applicant should normally be a customer and whose

account has been satisfactorily operated.2. Ascertain means, creditworthiness and standing of

the LC applicant.

3. Appraisal memorandum to be prepared / limits to besanctioned and in place.

4. LC limit to be commensurate with turnover / CC

Limit and should be for genuine trade / mfg.Activity.

5. Usance period should ordinarily have relation to WCcycle.


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6. Level of inventory to be commensurate with industry

norms / past trends.7. LCs for purchase of machinery / CG should be

backed by borrowers own funds or firm sanction ofTerm Loan.

8. A suitable margin depending on the applicantsmeans, creditworthiness, his other liabilities, etc.may be prescribed.

9. If warranted, a lien may be maintained on theunutilised portion of CC Account for the value of billsto be received under the LC.


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10. In respect of sister concerns or where applicant and

beneficiary are otherwise linked, there shouldordinarily be no need for LCs. Ensure againstkiteflying. Ascertain standing of the beneficiary.

11. Delivery against Acceptance (D/A) facilities shouldbe granted only to applicants of undoubted standingand where security available is much more than thevalue of LC.

12. LCs permitting payment against documents whichdo not confer on the Bank a full and undisputed titleto the relative goods to be treated as clean andshould not ordinarily be issued.


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13. Suitable insurance safeguarding the Banks interests,

on warehouse to warehouse basis, should beinvariably incorporated. If insurance is arranged bythe applicant, cover notes to be obtained and covernotes & insurance policies to be deposited with the

Bank.

14. The validity of Revolving LCs should not be formore than one year, and the value of the LC should

be based on the value of material the borrowerneeds for his genuine mfg. / trading requirementsduring this period. A special limit for the revolvingamount should invariably be stipulated.


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15. The application-cum-guarantee form should be

adequately stamped as an agreement.16. LC not to contain any contradictory clauses or any

other clause / condition impossible to fulfill and onewhich violates the laws of the country.

17. LCs issued should be entered in LC EstablishedRegister and LC Liability Register.

18. The application-cum-guarantee form after issue ofthe LC to be kept in strong room / fire proof safeand in the custody of the authorised officials.

19. LC to be serially numbered.


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20. LCs, inclusive of amendments, to be signed by two

authorised officials, when they are issued foramounts of Rs. 50,000/- and above.

21. Usance LCs or Capital Goods LCs to be opened onlyif provided for in the sanction.

22. The sanction / issue of LC should be as per thepowers delegated in the Scheme of Delegation ofFinancial Powers and other instructions issued from

time to time.

23. Before despatching the LC, ensure that the followingparticulars are contained in the LC:


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a. Particulars of Import Licence, if any

b. Full and correct address of the beneficiary

c. Precise / brief description of goods

d. Price of goods in words and figures

e. Origin of goods

f. Mode of transport Sea / Air / Land / Rail

g. Last date of shipment of goods, negotiation of docs

h. Port of shipment / destination

i. Whether part-shipment / trans-shipment permitted

j. Value of goods CIF / CF / FOB and its currency


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k. Payment terms DP or DA Tenor of bill

l. Expiry date of LC

m. Instructions regarding negotiation of documents andreimbursement

n. Documents to accompany the Lc and how manycopies are required: Draft, Invoice, B/L or AWB orR/R or L/R, Packing List, Weigh List, Certificate ofOrigin, Insurance Policy / Certificate, Quality

Certificate, Consumer Invoice / Certificate, InspectionCertificate


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OPENING OF IMPORT LCs : ADDL. POINTS

1. Ensure that the goods to be imported under the LC

are covered by valid Import Licence, whererequired, in the name of the customer or properlytransferred in his favour. Verify amount, balanceavailable, type of goods permitted, country of origin,

validity period, limiting factor (quantity and / orvalue), any special conditions imposed, etc.

2. The terms of payment stipulated in the Credit

should fall within the permitted methods of paymentas prescribed under FEMA.

3. In case Forward Contract has to be arranged, anundertaking to be obtained from the applicantagreeing to accept the rate ruling on that date.


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4. When 100% margin is recovered from applicants,

they should be advised that the margin represents amere deposit against the proposed Credit and thatall bills negotiated thereunder will have to be retiredat the rate of exchange ruling at that time, unless

the rate has been fixed under a FC.

5. In case of LCs to be opened for import of CapitalGoods, it is to be ensured that:

Beneficiaries of LCs are well reputed as revealed bythe Opinion Reports on the beneficiaries

LCs are established in favour of only those

beneficiaries who were indicated in the Project Report


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6. Banks standard clauses to be incorporated in the

LCs established and onerous responsibilitydetrimental to the Banks interests to be avoided.In case any special terms involving onerousresponsibility for the Bank are proposed by theapplicant or the beneficiary, the same wouldneed clearance by the concerned controllers.

7. Trade Control / Exchange Control requirements.

8. Credit norms of RBI.

9. UCPDC provisions.

10. Banks internal Credit policies / procedures.


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ASSESSMENT OF LC LIMIT : ILLUSTRATIONM/s XYZ COMPANY LIMITED

LETTER OF CREDIT LIMIT OF Rs. 20 CRORES(Rs. in crores)

Total purchase of Raw Materials (RM) 172.64

Purchase of RM under LC 69.41

Average monthly purchase of RM [A] 5.78

Average usance period [B] 3 months

Lead time & transit period [C] 1 month

Total of [B] & [C] [D] 4 months

Requirement of LC Limit [A] x [D] 23.12

LC Limit recommended 20.00


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ASSESSMENT OF LC LIMIT

While assessing Letter of Credit Limit, the

following points need to be noted: Purchases of RM on LC basis should be net of

Import Duty

Transit time should be treated as Nil if usanceperiod starts from shipment date


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NEGOTIATION OF BILLS UNDER LCs

The following approach should be adopted while

fixing limits for purchase of bills drawn under LCsof branches of SBI / Correspondent Banksabroad / First Class Banks in India, identified forthe purpose by Corporate Centre:

a. Banks existing customers: Limit fixation shouldessentially be based on the assessment of volumeof sales, which is expected to be backed by LCs

and the terms thereof.

As far as possible, fixing of these limits shouldcoincide with the sanction / renewal of ABF.


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NEGOTIATION OF BILLS UNDER LCsWhenever these limits are required to be fixed or

enhanced subsequent to the sanction of ABF, theassumptions in regard to the level of Receivablesmade at the time of sanction of limits should bereviewed and if required, ABF re-assessed to

ensure that there is no overfinancing.It should also be ensured that Receivables backedby LCs are excluded in the Book Debts statementfor the purpose of Drawing Power.

b. For borrowers of other banks:Fixation of the limitwould essentially be related to the volume ofbusiness under such LCs proposed to be given by

the Bank and the terms thereof.


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NEGOTIATION OF BILLS UNDER LCsIn all the cases of non-borrowers, including

borrowers of other banks, past financial datashould be called for and the following aspectsshould be satisfied:

i. Business is conducted satisfactorily

ii. There are no liquidity problems in the business

iii. Net Worth is adequate

iv. Past experience in regard to payment of bills purchased

is satisfactory

In such cases, there will be no need to obtain aNOC from the financing bank. A brief note

covering the above aspects should be recorded.


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NEGOTIATION OF BILLS UNDER LCsc. Stray purchases: While no specific limit need be

sanctioned for this purpose, the borrowersliability in such cases should be limited to one ortwo bills and the amount thereof should notexceed the capacity to meet the amount in the

event of default.


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NEGO/DISC. OF LC BILLS SPECIFIED BRs

Circles should permit use of the unrestricted

powers for purchase of LC bills only at certainspecified branches, which would be done withthe approval of the Circle CGM. Thus, sanction oflimits for purchase of demand and usance bills

drawn under LCs (Export or Domestic) will be byexercise of the unrestricted power at only thedesignated branches, Category A branches and

Category B branches which are authorised topurchase export bills.


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Such unrestricted powers will be exercised only

in respect of bills drawn in conformity with theterms of LCs opened by:

a. Branches of SBI

b. Correspondent banks abroad as authorised andsubject to the restrictions imposed by the Banks ID /FD from time to time, and

c. First class banks in India identified as such from time

to time by Corporate Centre


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Bills conforming to LCs (export or domestic)

opened by approved banks [b and c above] aswell as those opened by SBI branches arespecified security and hence, such billspurchased and discounted will be outside the

purview of Total Indebtedness. Such bill limitswill be assessed and sanctioned outside the ABFand no restriction is imposed on powers of BMs

for purchase hereof.


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Thus, while the rest of the limits in a proposal

will be sanctioned by the appropriate authority interms of the present Scheme of Delegation ofPowers, the LC Bills Limit will be permitted to besanctioned by the BMs of the specified branches

in respect of advances handled thereat.

This will be an exception to the instruction thatthe highest authority to sanction a facility in a

single proposal should sanction all the facilitiesrecommended in the proposal.

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Discrepant bills as also bills drawn under LCs

opened by banks other than those mentionedabove, will be purchased only as part of thelimits sanctioned for non-credit bills.

The above procedure will be applicable forsanctioning limits to borrowers of the Bank andalso non-borrowers including borrowers of otherbanks.

GO/ SC O C S O S C


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NEGO/DISC. OF LC BILLS NON-SPEC. BRs

At non-specified branch, a limit for purchase of

bills drawn under LCs of all banks should besanctioned within the powers for advancesagainst bills vested either with the BranchOfficials or with a higher authority, as per

Scheme of Delegation of Financial Powers.

Exercise of these powers will be within the TotalIndebtedness ceiling applicable to the official

concerned.

Financing of such bills will be within the ABF.

NEGO/DISC OF LC BILLS NON SPEC BR


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NEGO/DISC. OF LC BILLS NON-SPEC. BRsWhen limit for purchase of bills under LCs for a

customer of non-specified branch is to besanctioned by the Controller of the Branch, hewould exercise only his powers for sanction ofadvances against bills and not his unrestricted

powers for sanction of bills under LCs.

In respect of stray purchase of bills under LCs, anon-specified branch will have to ensure that while

no specific limit need to be sanctioned for thispurpose, the borrowers liability in such casesshould be limited to one or two bills and theamount thereof not to exceed the capacity to

meet the amount in the event of default.

NEGO OF BILLS UNDER LC PRECAUTIONS


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NEGO OF BILLS UNDER LCs : PRECAUTIONS

Notwithstanding the availability of LCs, the

following should be ensured while negotiatingbills:

Genuineness of the LC

Genuineness of the underlying transaction byperusing the relative invoices, contracts or orders,etc.

Scrutiny of RR / Truck Receipts / Bill of Lading

tendered to verify their genuineness, quality andquantity of merchandise covered by them, the date ofissue, etc., and to ensure that transport receipts arefrom approved carriers and are not stale

NEGO OF BILLS UNDER LC PRECAUTIONS


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NEGO OF BILLS UNDER LCs : PRECAUTIONS Past track record of payment of bills under LCs

Caution to be exercised in respect of bills coveringsales within a city or locality and between groups /associate concerns and those drawn by frontcompanies of industrial groups

Verify the standing and creditworthiness of theborrower as well as the drawee of the bills

OBTENTION OF DOCUMENTS


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OBTENTION OF DOCUMENTS

As a general rule, a charge on the Current Assets

is not contemplated to be taken as security forthis facility for the reason that bill purchases fullyconforming to the terms of LCs opened by firstclass banks and other branches of SBI are

treated on par with the advances againstspecified security.

However, where the nature of the borrowers

overall operations and his track record warrantsstrengthening of the security cover, these maybe prescribed and appropriately covered.

CRA RATING FOR LC BD FACILITY


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CRA RATING FOR LC BD FACILITY

While CRA rating is not required for the limits

under LCs sanctioned outside the TotalIndebtedness at specified branches, such ratingwould be necessary for limits granted at non-specified branches inasmuch as these will be a

part of the ABF and within the TotalIndebtedness ceiling.

SEPARATE LIMITS EXPORT / INLAND


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SEPARATE LIMITS : EXPORT / INLAND

In the case of both borrowers and non-

borrowers, separate limits for purchase of billsunder LCs will be sanctioned for Export Bills andInland Bills.

TREATMENT OF STOCKS COVERED BY


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TREATMENT OF STOCKS COVERED BYUSANCE IMPORT LCs

Earmarking of lien for the outstanding usanceimport LC bills against AVS ensures provision ofmargins on the stocks covered by usance LCsright from the time the stocks are bought on

credit backed by the Banks commitment.

This provision ensures that the margin isavailable well before the CC Account is debited

for the matured LC bill.

TREATMENT OF STOCKS COVERED BY


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TREATMENT OF STOCKS COVERED BYUSANCE IMPORT LCs

In cases where the bills drawn under LC arereceived but the relative goods are not yetreceived, the sanction for CC Limit may providefor facility of drawings against the documents of

title to goods received under the Banks usanceLCs.

In such cases, lien for the full amount of the

outstanding bills may be earmarked against theAdvance Value of the total stocks including thedocuments of title to goods received under theBanks LCs.

RESTRICTION OF NEGOTIATION


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RESTRICTION OF NEGOTIATION

Restriction of negotiation of bills drawn underour LCs only to the Banks branches is adesirable marketing strategy to the extentfeasible.

In cases where negotiation is not restricted, theBanks branch in the drawee centre should bealerted to attract the business of LC billdiscounting.

RETIREMENT OF BILLS NEGO - FOLLOW-UP


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RETIREMENT OF BILLS NEGO FOLLOW UP

a. Branches should scrutinise on receipt alldocuments negotiated under the Banks LC forany discrepancies and non-compliances of T & C.If necessary, they should consult the applicantwhether to retain the bills or return them in the

event of discrepancies.

b. Branches should take immediate steps to protectthe Banks interest in the goods in case payment

is not made by the applicant on presentation ofthe bills. These would include advising theRailway authorities or transport company of theBanks interest in the goods and ensuring thecontinuance of insurance a ainst theft fire etc.



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c. Bills drawn under LCs will be retired on receiptby debit to the applicants account. Only areasonable period should be allowed toimporters for retirement of bills drawn under LC.

A period of 7 days is recommended for this

purpose. This should be advised to thecustomers at the time of establishing LCs.

d. Request for time for retirement of bills till the

arrival of the goods can be entertained on beingsatisfied that the bills would be paid immediatelyon the arrival of the goods.



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e. In the meantime, necessary confirmation of thedrawees that the documents are in order and areacceptable to them should be obtained andrecorded at the Branch.

f. Where LCs have been opened against a validImport Licence, and on arrival of goods thelicence holder does not honour the bills drawnagainst the LC and does not produce the licence

for the clearance of the goods, the Branch whichhas opened the LC will be able to clear thegoods through Customs and remit the forex tothe foreign suppliers / beneficiary by debit to thelicensee in uestion.



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g. For the purpose of clearance of goods, theBranch will provide Customs with certificatestogether with the Exchange Control copy of thelicence to the effect that the import has beenmade and forex has been remitted by the Branch

under the authority of a valid import licence anda confirmed irrevocable LC.

DEVOLVEMENT OF LC BILLS


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The following approach should be adopted bybranches to avoid problems arising fromdevolvement of LCs and the resultant excessdrawings in the relative accounts:

a. While opening LCs, branches should satisfy

themselves that the customer would be in a positionto retire the bills when received. For this purpose,they may obtain cash flow projections and make anintelligent scrutiny to be sure about availability of

funds on the due dates.

b. The limits for Demand LCs and Usance LCs should beassessed separately with ample justifications. Theusance period should not generally exceed theroduction c cle.



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c. In case of bulk imports, a longer usance period maybe considered selectively.

d. When liability under LC is met by creating anirregularity in the CC Account, the relative LC Limitshould not be released for opening further LCs till theaccount is adjusted. In other words, the liabilityshould not be marked off in LC Liability Registermerely because of retirement of documents. Therelative liability should be marked off only after theaccount is regularised.

e. In case of devolvement, if the irregularity in theaccount is not adjusted within 15 days, or if the LCdevolved earlier is not adjusted, no further LCs should

be opened without adequate margin.



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f. In persistently defaulting cases, cancellation of LClimits should be considered.

g. Excess liquidity available during the usance period ofLCs enables the borrowers to divert short-term fundswhich leads to devolvement. Lien has to be markedfor the outstanding usance LC bills on the AVS as ageneral rule and Circles have been permitted to marklien on the MVS selectively, to be permitted by CGM.

h. Where Usance LCs are sanctioned, this should be

borne out by the appraisal data relating to SundryCreditors.

i. Transactions in the account and the FFRs should beclosely monitored to check diversions.



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j. Branches should not permit excess drawings inaccounts which show persistent irregularity due to

devolvement of LC bills.

k. The practice of allowing excess drawings against thecredits made in the account, leaving the existingirregularity unadjusted, should also not be permitted.

l. In case of sick / weak units, requests for Usance LCfacility should be examined with greater care.

All cases of LC devolvement will have to bereported to the Controllers within 7 days ofdevolvement as per LC-3. Irregularity Reportshould also be submitted to the appropriate

authority in the usual manner.



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Branches should also furnish to their Controllersdetails of devolved LCs at quarterly intervals asper LC-4.

In branches where Concurrent Auditors havebeen posted, they may be entrusted with thetask of monitoring the devolved LCs byfurnishing a certificate to the Controllers at theend of every month stating that the details of all

LCs devolved on the Bank during the monthhave been duly reported.

CRYSTALLISATION OF IMPORT BILLS


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Sight bills under Import LC and in conformitywith the terms thereof shall be crystallised if notretired by the customer on the 10th day from thedate of receipt thereof by converting the ForeignCurrency amount into Rupees at the Banks Bill

Selling Rate prevailing on the date of conversion(crystallisation) or at the contracted rate, if a FChas been booked for the purpose.

The crystallisation should be done by debit to aGL account Advance made to customers againstImport Bills and the credit is to be put throughand reported as sales to FD, Kolkata.



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Usance bills under Import LC and in conformitywith the terms thereof, may on acceptance, beheld in Foreign Currency upto the date ofmaturity.

In the vent of non-payment on the due date, theimporters liability shall be crystallised byconverting the Foreign Currency amount intoRupees at the Banks Bills Selling Rate prevailing

on the due date or at the contracted rate in casea FC has been booked.

The crystallisation should be done by debiting

straight away the CC Account of the importer.



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If the importer does not have CC Account, therelative debit should be raised to his Current

Account.

The transactions should be reported as sales toFD, Kolkata, indicating that these relate tocrystallisation of import bills.

Branches should refer to circulars issued by FD,Kolkata for detailed accounting procedure inregard to crystallisation of bills under ImportLCs.

INTERCHANGEABILITY OF LIMITS : LC / BG


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Generally, requests for inter-changeabilitybetween the two facilities shall be entertainedonly when the purposes for which the facilitieshave been sanctioned are similar.

The extent to which such inter-changeability canbe permitted, subject to detailed examination ofcircumstances requiring such inter-changeability,is as under:

Type SB-4 and above SB-5 and below

From BG to LC 100% 50%

From LC to BG 100% 25%



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INTERCHANGEABILITY OF LIMITS : LC / BGThe inter-changeability from LC to BG and vice-versaneed to be considered with caution as there would be

change in quality of underlying exposure. Further, thefollowing points are to be considered:

a. Time horizons of risk devolvement between the twofacilities are different.

b. Nature of risk is not the same, i.e. the risk associated witha performance guarantee is different from that of afinancial guarantee or an LC.

c. While examination of cash flows is vital at the time of

opening an LC, it is not generally considered as relevant inmost cases of issues of BGs.

d. An usance LC limit has a bearing on the level of SundryCreditors available and hence on the FB credit limit

required.


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CHAPTER 2BANK GUARANTEES

INTRODUCTION


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INTRODUCTION

A contract of guarantee is defined as a contractto perform the liability of a third person in caseof default. The parties to the contract ofguarantee are:

a. Applicant : The principal debtor : The person at whose

request the guarantee is executed.

b. Beneficiary : The person to whom the guarantee is givenand who can enforce it in case of default.

c. Guarantor : The person who undertakes to discharge theobligations of the applicant in case of his default.

Thus, a contract of guarantee is a collateralcontract, consequential to a main contractbetween the a licant and the beneficiar .

PURPOSE OF ISSUE OF BGs


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BGs may generally be issued for the followingpurposes:

a. In lieu of Security Deposits / Earnest Money Depositsfor participating in tenders.

b. Mobilisation advance or advance money beforecommencement of the project by the contractor andfor money to be received in various stages like plantlayout, design / drawings in project finance.

c. In respect of raw material supplies or for advances bythe buyers.

d. In respect of due performance of specific contracts bythe borrowers and for obtaining full payment of thebills.



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PURPOSE OF ISSUE OF BGse. Performance guarantee for warranty period on

completion of contract which would enable the

supplier to realise the proceeds without waiting forthe warranty period to be over.

f. To allow the units to draw funds from time to timefrom the concerned indentors against past executionof contracts, etc.

g. Bid bonds on behalf of exporters.

h. Export performance guarantees on behalf ofexporters favouring the Customs Department underEPCG Scheme.

GUIDELINES ON CONDUCT OF BG BUSINESS


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Branches should, as a general rule, limitthemselves to the provision of FinancialGuarantees and exercise due caution with regardto Performance Guarantee business.

The subtle difference between the two types ofguarantees is that under a Financial Guarantee,a bank guarantees the customers (applicants)financial worth, creditworthiness and his capacity

to take up financial risks.In a Performance Guarantee, the banksguarantee obligations relate to the performance

related obligations of the applicant (customer).



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While issuing Financial Guarantees, branchesshould satisfy themselves that customers wouldbe in a position to reimburse the Bank in casethe Bank is required to make the payment underthe guarantee.

In case of Performance Guarantee, branchesshould exercise due caution and have sufficientexperience with the customer to satisfy

themselves that the customer has the necessaryexperience, capacity, expertise and means toperform the obligations under the contract andno default is likely to occur.



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Branches should not issue guarantees valid formore than 18 months without obtaining prioradministrative clearance of the appropriateauthority through their respective controllingauthorities.

No Bank Guarantee should normally have amaturity of more than 10 years. BG beyondmaturity of 10 years may be considered against

100% cash margin with prior approval of theControllers.



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GU S O CO UC O G US SS

Branches should normally refrain from issuingguarantees on behalf of customers who enjoyother credit facilities not with them but withother banks.

Unsecured guarantees, where furnished by

exception, should individually be for a shortperiod and for relatively small amounts.

All DPGs should ordinarily be secured.

APPRAISAL OF BG LIMIT


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Branches should appraise the proposals forguarantees with the same diligence as in thecase of FB Limits. They may also obtainadequate cover by way of margin and security soas to prevent default on payments when

guarantees are invoked.Whenever an application for the issue of BG (orsanction of a regular BG Limit as part of WC

Limits) is received, branches should examine andsatisfy themselves thoroughly about thefollowing aspects:

APPRAISAL OF BG LIMIT


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a. The need for the BG and whether it is related to theapplicants normal trade / business.

b. Whether the requirement is one-time or on a regular basis.

c. The nature of BG, i.e., Financial or Performance.

d. Applicants financial strength / capacity (through an analysis

of his financial statements, Cash & Funds Flow position andopinion reports) to meet the liability / obligation under theBG in case of invocation.

e. Past record of the applicant in respect of BGs issued earlier,

e.g., instances of invocation of BGs, the reasons thereof, thecustomersresponse to the invocation, etc.

f. Present outstanding on account of BGs already issued.

g. Margin

h. Collateral securit offered.

ASSESSMENT OF BG LIMIT


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Assessment of BG Limit

MARGINS
http://localhost/var/www/apps/conversion/tmp/scratch_10/ASSESSMENT%20OF%20BG%20LIMIT.dochttp://localhost/var/www/apps/conversion/tmp/scratch_10/ASSESSMENT%20OF%20BG%20LIMIT.doc


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Following are some of the factors to be kept inview by the branches while determining the

margins required:

a. Cash margins provide a cushion against invocation.Margin money may be in the form of TDR or a lien

marked on the DP in the constituents CC Account.(Specific approval of sanctioning authority is required inrespect of the latter).

b. The margin to be stipulated would depend on the

borrowers means, resources, creditworthiness, securityavailable, past experience with regard to issue of BGs,nature of guarantee and the nature of underlyingtransactions. If existing borrower, margin on BG may

generally be the same as on Stocks, Receivables, etc.

MARGINS


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c. In case of Advance Payment Guarantees, lowermargins may initially be stipulated. Once the advance

is actually received, depending on the amount notlikely to be immediately utilised, higher margins maybe built up by impounding of cash advances.

d. In respect of non-borrower applicants, Banksapproach should normally be to obtain full margins.However, a credit risk can be taken on the applicantsbased on the financial indicators, credit worthiness,security available, etc.

e. 100% margin should ordinarily be retained in respectof guarantees issued in connection with disputedCustoms / Central Excise duties, unless otherwise

specified in the sanction.

SECURITY


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Apart from the margin, BGs are usually securedby an extension of the charge on Current Assets

obtained to cover WC facilities.

Adequate collateral security by way of EquitableMortgage / Extension of charge on Current /

Fixed Assets or third party guarantee should betaken depending on the merits of each case.

DOCUMENTS


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Whenever a guarantee is issued and / orguarantee bond is countersigned by the Bank on

behalf of a constituent, suitable CounterGuarantee should be obtained from theconstituent.

For each ad hocBG issued, a separate CounterGuarantee is necessary.

In the case of a regular BG Limit duly

sanctioned, a stamped Omnibus CounterGuarantee for the BG Limit will suffice.

DOCUMENTS


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In case of a Partnership Firm, Counter Guaranteesshould be signed / executed by all the partners of

the Firm.

In case of Joint Stock Company, a BoardResolution should be got passed by the Company

before executing the Counter Guarantee orOmnibus Counter Guarantee.

Both the Bank Guarantee (to be executed by the

Bank) and the Counter Guarantee or OmnibusCounter Guarantee (to be executed by theapplicant / borrower) are to be stamped asagreements as per Stamp Duty required at the

lace of execution.

FORMAT OF BANK GUARANTEES


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BGs should normally be issued on the formatstandardised by IBA. When it is required to be

issued on a format different from the IBA format,as may be demanded by some of the beneficiaryGovernment Departments, it should be ensured

that the BG is:a. For a definite period.

b. For a definite objective enforceable on the happening of adefinite event.

c. For a specific amount.

d. In respect ofbona fidetrade / commercial transactions.

e. Contains the Banks standard limitation clause.



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f. Not stipulating any onerous clause.

g. Not containing any clause for automatic renewal of the BG

on its expiry.

BGs should be issued with a pre-printed andnumbered standard first page of the guarantee

form, which contains the limitation clause.

The pre-printed form is to be used for all BGs.

However, in case of a guarantee favouring aGovt. Dept. objects to the use of the pre-printedform, branches may issue the guarantee on non-

judicial stamp paper.



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The text of the guarantee will appear on thepages succeeding the printed first page. It

should be ensured that while filling up the firstpage of the BG, no separate claim period isprovided.

The validity period of the guarantee will bestated inclusive of the claim period.

Further, each page of the text of the guarantee

enclosed with the pre-printed form should alsomention pre-printed serial number, BG number,date of issue and amount, etc.



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In all the guarantees issued by the Bank, thelimitation clause suggested by IBA should

invariably be incorporated at the end of the extas concluding paragraph of the BG.

Notwithstanding anything contained herein:

a. Our liability under this BG shall not exceed Rs. (Rupees only);

b. This BG shall be valid upto..; and

c. We are liable to pay the guaranteed amount or any partthereof under this BG only and if only if you serve upon usa written claim or demand on or before . (date ofexpiry of guarantee).



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In case of BGs issued favouring Govt. Depts., theabove clause should be incorporated in the

Model Bank Guarantee (MBG) form, prescribedfor BGs in favour of Govt. Depts.

If period of claim is required to be stated

separately, it has to be kept at the minimum. Itshould generally not exceed 3 months.

The BG may be issued on a stamp paper on

which the name of the customer appears as thepurchaser thereof.

BGs for Rs. 50,000/- and above to be signed by

two officials ointl with their SS numbers.

EXTENSION / RENEWAL OF BGs


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Branches may entertain requests from theapplicants for extension / renewal of guarantee

provided there is no change in the amount andother terms and conditions of the guarantee.

Expired BGs may also be renewed with

retrospective effect subject to the condition thatthe Bank remains indemnified as against thecontingent liabilities, etc., which may arise under

the said guarantee, i.e., the Counter Guaranteecovers such liabilities retrospectively.

EXTENSION / RENEWAL OF BGs


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Normally, requests for extension should emanatefrom the applicants. In case, however, the

beneficiaries request the branches either torenew or pay the guarantee amount, thebranches should acknowledge such letters to the

beneficiaries and request the applicants to renewbefore the guarantees expire or deposit theguarantee amount for honouring thecommitment. If no request for renewal is

received by the branches in time, they shouldhonour the guarantees invoked and recover theamount paid from the applicants in the usual

manner.

ISSUE OF BGs WITH AUTOMATIC RENEWAL CLAUSE


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Requests may be received from the undernotedauthorities / concerns in respect of units

financed by the Bank for issue of guaranteeswith an automatic renewal clause:

Customs Authority for guarantees relating to import

of capital goods / raw materials

Courts towards disputed liabilities

Overseas Project Owners in respect of project exports

Such requests may be entertained in line withextant instructions.

AMENDMENT OF BANK GUARANTEE


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There is no provision for amendment of BankGuarantees unlike in the case of Letters of

Credit.

Instead, fresh guarantees need to be issued,cancelling the earlier ones.

TERMINATION / CANCELLATION OF BG


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After the expiry of each BG (including the timelimit stipulated for preferring claim, if any), a

registered letter with A.D. should be sent to thebeneficiary advising that the guarantee hasexpired and requesting the beneficiary to return

the original guarantee.It should be made clear in the letter that thebeneficiary is no longer entitled to invoke the

guarantee.If the guarantee is not returned within a periodof 1 month, a reminder should be sent.



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Thereafter, liability in branch books reduced bythe amount of expired guarantee.

Margin money and the collateral, if any, takenexclusively for the relative guarantee may thenbe refunded.

Branches should periodically verify theoutstanding guarantees and take appropriateaction for cancellation of outstanding guarantees

beyond the respective dates of expiry / claim.



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Bank Guarantee can be cancelled:

a. Prior to expiry of the period only with the writtenconsent of the two parties to the contract, i.e.,the beneficiary and the applicant, or

b. On the expiry of claim period.

In cases where the guarantee duly cancelled isreceived back before the expiry date, the liabilitywill be marked off in branch books. However,the commission for the balance period is notrefundable if the purpose for which theguarantee was issued has been fulfilled.



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Branches should diarise two months beforeexpiry date and advise the applicant to take

steps for either renewal or release of theguarantee.

The applicant should also be put on notice that

the Bank would be honouring the claim withoutfurther reference if the guarantee is invokedconsequent upon non-renewal in time.

REVERSING THE ENTRIES RELATING TO EXPIRED BGs


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On expiry of a BG, a registered letter advisingthe expiry of the guarantee and requesting for

returning the original guarantee documentshould be sent to the beneficiary. After thelapse of a period of say 1 month, whether the

original BG is returned or not, branches wouldcarry out the following:

a. Reverse the entries relating to the BG in theCustomer Liability Register and the Proforma Accountin the GL.

b. Mark off the BG in the Guarantee Register.

c. Return the margin money and the collateral, if any,

exclusivel taken for the BG.

REVERSING THE ENTRIES RELATING TO EXPIRED BGs


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Branches would review the position before 10thof March every year and confirm to their

Controllers that no expired guarantee (beyondthe waiting period of 1 month for receipt of theexpired BG) is reflected as outstanding in their

respective books.Non-compliance would result in inflating theContingent Liability of the Bank, thereby

imposing an avoidable need to meet theadditional Capital Adequacy requirement.

INVOCATION OF BANK GUARANTEE


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The beneficiary of the BG can invoke in writing,the guarantee any time before the expiry of the

guarantee period. Invocation can be done byTelex / Telegram / Hand Delivery also followedby Mail Confirmation.

Branches should ensure that all valid claimsreceived by them under BGs issued by them aresettled promptly.

In the case of any dispute, such honouring, oninvocation, will be done under protest and thematters of dispute should be pursued separately.



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The Banks liability under BG is absolute andindependent and exclusive of any other contract

entered into by the applicant and beneficiary.

It is, therefore, obligatory on the part of theBank to pay to the beneficiary without delay and

demur the amount of BG on its invocation inaccordance with the terms and conditions of theguarantee deeds.

It is not necessary for the beneficiary to satisfythe Bank about the default or the amount ofactual loss suffered by him.



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In this connection, BMs have been vested withnecessary powers to honour the claims under

the guarantees issued by the Bank, provided theguarantee was executed under sanction from thecompetent authority and conditions stipulated for

invocation of the guarantee have been fullycomplied with.

Delay in honouring the claim immediately may

unnecessarily put the Bank in problemspertaining to claim of interest, damages and attimes injunction orders from Court.



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Only when the Bank has received an order ofrestraint / injunction from a competent /

appropriate Court, the Bank can withholdpayment under the BG. The liability of the Bankunder the BG will continue till the Court case is

decided.The beneficiary of the guarantee should beadvised appropriately of the reason for non-

payment of amount due under invokedguarantee.

DEFERRED PAYMENT GUARANTEE (DPG)


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A DPG is a contract to pay to the supplier theprice of the machinery supplied by him on

deferred terms to the buyer, in agreedinstalments with stipulated interest on therespective due dates in case of default in

payment by the buyer.Under the contract, the Bank executes aguarantee on behalf of the buyer to the sellers

banker, who on the strength thereof, discountsthe sellers bills drawn on the buyer.



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The seller receives payment for the P&M by hisbills being discounted by his banker, and the

buyer repays his obligations in instalments to thesellers banker by retiring those bills on therespective maturity dates.

The period of DPGs should not ordinarily exceed7 to 10 years.

The standard covenants for DPGs are generally

the same as those for Term Loans.



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Where both the buyer and seller have commonbanking arrangements, i.e., both are Banks

constituents, DPGs as such will not be requiredto be executed. Instead, the Branch whichhandles the buyers account will issue a Letter of

Commitment to the discounting Branch handlingthe sellers account, authorising the discount ofbills without a separate DPG.

The issue of such a Letter of Commitment onbehalf of the buyer, however, should be treatedon par with a DPG for all purposes.


h l b l f h k d ll b h


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The liability of the Bank under DPG will be theamount for which the guarantee is issued

inclusive of interest. The liability should bereduced by the amount of instalments, inclusiveof interest component, as and when they are

paid.In the case of DPGs issued in forex, theconversion rate for control entries will be the BC

Selling Rate for the currency concerned ruling onthe date the guarantee is issued. Entries will bereversed as and when the amounts are paid, atthe same rate at which the original entry was

assed.

EXPORT PERFORMANCE GUARANTEES

E P f G h hi h


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Export Performance Guarantees are those whichare executed favouring the Customs Department

for amounts linked to the Customs Duty reliefavailed by the exporter customers on imports ofcapital goods under the Export Promotion Capital

Goods Scheme.The guarantees are for the due fulfilment of aspecified level of export obligation undertaken by

a customer to avail of the Customs Dutyremission on the imports.

BGs IN FAVOUR OF OTHER BANKS / FIs

B h h ld i f i


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Branches should not issue guarantees favouringother banks / FIs / other lending agencies for

the loans extended by the latter, as it is intendedthat the primary lender should appraise andassume the risk associated with sanction of

credit and not pass on the risk by securing itselfwith a guarantee.

JUDGEMENTS BY COURTS

Th f ll i d h ld b d t d


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The following procedure should be adoptedwhen judgements are delivered by Courts in

respect of guarantees issued in favour of Govt.Depts. :

a. Where the Bank was a party to the proceedings

initiated by Govt. for enforcement of the BG and thecase was decided in favour of the Govt. by the Court,branches need not insist on production of certifiedcopy of the judgement as the judgement / order was

pronounced in open Court in the presence of theparties / their counsels and the judgement would beknown to the Bank.

JUDGEMENTS BY COURTSb I th B k t t t th di


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b. In case the Bank was not a party to the proceedings,a signed copy of the minutes of the order certified by

the Registrar / Deputy / Assistant Registrar of theHigh Court or the ordinary copy of the judgement /order of the High Court, duly attested to be true copyby Govt. Counsel, would be sufficient for honouring

the obligation under the guarantee, unless the Bankdecides to file any appeal against the order of theHigh Court.

BGs FVG. GOVT. DEPTS : CORRESPONDENCE

I t f t i d b th b h


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In respect of guarantees issued by the branchesfavouring Government Departments, branches

should not address any correspondence to thePresident of India, although such guarantees arefavouring the President of India.

The correspondence relating to such guaranteesshould instead be addressed to the concernedGovt. Ministry / Departments.


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THANK YOU